Four Sectors to Avoid When Interest Rates Rise
by Jason Jenkins, Investment U Research
Thursday, August 11, 2011
Okay…. the United States government didn’t default on August 2. But the downgrade on Friday should finally get Washington’s attention.
What we have to understand is that the debate wasn’t just about raising the debt ceiling so we could pay our creditors.
The true issue revolves around our inability to keep up this massive spending. No matter what your politics, there has to be a major change in the way we do government.
Also, dysfunctional government doesn’t give a sense of credibility or soundness to the rest of the world.
Friday’s Credit Downgrade Couldn’t Be Prevented
More than $2.4 million in deficit cuts over 10 years with no tax reform or strategy to reign in entitlement spending couldn’t prevent Friday’s credit downgrade.
And the country is on the brink of yet another downgrade, and it could happen anytime before the end of summer.
With our debt now downgraded, the Federal Reserve will need to take immediate steps to make Treasury debt more attractive to creditors.
This presupposes higher interest rate payments to creditors to offset the downgrade. That will be the first domino to fall.
In response to the Fed, banks will raise their interest rates to compete with the new attractiveness of Treasuries to investors.
Four Sectors Directly Affected by Interest Rate Inflation
What you need to know are the four sectors that will be most directly hurt and directly affected by this interest rate inflation.
- Obviously, the sector that’ll be most affected will be the financial services industry – more specifically U.S. retail banks. If a bank has to raise rates to be competitive, it’ll be paying out more money in interest rate payments. The more it pays out, the less profitable it’ll be. You may want to note that many analysts believe that the fear of rising interest rates have been priced into bank stocks since earlier this year.
- Real estate investment trusts (REITs) will also feel the brunt of increased rates. REITS need to be able to borrow money cheaply. Rising rates will hurt profitability. Most analysts believe that rising rates haven’t been priced into these trusts.
- There are two major factors that place utilities in line of fire. Utilities are in competition with bonds for investment dollars. A rise in interest rates will make bonds more attractive and take investment dollars from the industry. Secondly, because utilities require a great deal of infrastructure, they carry large amounts of debt on their books. Their high debt loads make utilities extremely sensitive to changes in interest rates. When interest rates rise, debt payments will increase.
- Fixed income vehicles currently in the market will lose value when rates rise. It’s Investing 101 according to debt. When rates go up, value decreases. New bonds and preferred stocks that are issued with higher coupon rates will look better than older bonds issued with a lower coupon. This environment usually translates into a current fixed income sell-off as funds are deployed into newer bonds and preferred shares.